Many episodes of monetary inflation, some even long and virulent, do not feature a denouement in a sustained high CPI inflation over many years. Instead, these episodes have the common characteristics of asset inflation and the monetary authority levying tax in various forms – principally inflation tax or monetary repression tax. For the monetary inflation to undergo combustion into sustained high CPI inflation it must generate necessary one or two necessary conditions. First, currency collapse; or second, a credit boom which spawns a persistent tendency of demand to exceed supply at present prices across a broad range of markets in goods and services.
That combustion happened in the 1970s in the US well into the severe monetary inflation which started in the early 1960s; it did not happen in the 1920s in the US, and it has not yet happened in the great monetary inflation in the US starting early in the second decade of the twenty-first century. The combustion process did get under way in the series of monetary inflations between 1985 and 2007 but was halted each time by a severe tightening of monetary policy.
Combustion did not occur according to the historians in the great monetary inflation of the 16th and first half of 17th century as gold and silver flowed in from the Spanish conquests in South America. We read about the symptoms of virulent asset inflation in Holland, then the centre of global finance, whether tulipmania or the wild ascent of shares in the Dutch East Company, or the speculative boom in Amsterdam real estate. The annual average rise of prices, however, was in a range of only 1 to 1.5 per cent over more than a century, albeit enough cumulatively according to some historical accounts to be a principal factor in bringing about social, religious, economic and political revolution.
Even where we have rampant credit growth stimulated by monetary inflation, that may not be enough to bring about combustion into high CPI inflation. Disinflationary non-monetary forces may be enough to prevent this. These include a surge in productivity growth, globalization, and new competition from technological change. That was the story of the 1920s in the midst of the second industrial revolution. And if combustion had eventually taken place high CPI inflation would have run up against resistance from the automatic mechanisms still potentially operational under the truncated gold standard of that time.
In the Great Inflation of the 1970s, we had both necessary conditions for combustion. First, the Fed fuelled a global inflationary credit boom. Its efforts to act in solidarity with President Johnson in pursuing the Vietnam War and later with President Nixon to get re-elected jarred with the dollar zone as a whole being in a spectacular growth period (miracles in Europe and Japan which until the early 1970s were part of the dollar zone) with presumably a high natural interest rate. Second, the Nixon Administration aggressively devalued the dollar through 1971-3.
Fast forward to the era since the mid-1980s when the US abandoned its brief monetarist experiment. We can see in the late 1980s a process under way towards a new sustained high CPI inflation, but this was stopped in its tracks by the 1989-90 Greenspan monetary squeeze. That combustion process occurred in the context of a large dollar devaluation – officially orchestrated at first with the Louvre Accord (1985) and then driven by the last gasp of German monetarism in defiance of the US inflationary hegemon. In the US domestically there was the rampant credit boom featuring the savings and loan institutions.
A new great monetary inflation started in the mid-1990s. The coincidental third industrial revolution, however, preventing a combustion process from emerging at first. A powerful related growth in productivity joined with other non-monetary disinflationary forces including globalization and resource abundance.
Even so the Bush devaluation of 2003-5, together with the stepped up monetary inflation, did drive CPI inflation higher (breaching 4 per cent) to which the Federal Reserve eventually responded severely through 2005-7, playing a key role in the unfolding of the Crash and Great Recession of 2007-9. Counterfactually if the Fed had not responded, the great monetary inflation starting in the mid-1990s would have persisted; perhaps combustion would have taken place, or it might have undergone metamorphosis into a great asset deflation before that point.
Then we come on to the post 2010/11 period. How virulent has money inflation been since then? Not easy to say in a deeply corrupted monetary system without a high-powered money base in any meaningful sense. Detectives of monetary inflation have to look for clues including the manipulation of short and long-term interest rates on the one hand and on the other multiple symptoms of asset inflation – buoyant carry trades (whether in credit, currencies, or term structure of interest rates), speculative storytelling and a boom in financial engineering.
The race to the bottom, however, amongst fiat monies means that there has been no sustained dollar depreciation. There has been a credit binge in China, facilitated by US monetary inflation and its spread internationally; even here, though, we have not seen combustion into high inflation. In the case of the US, growing monopolization, mal-investment, awareness about the endgame of Crash and Great Recession, might all have contributed to a sclerosis of the economic system meaning that credit growth did not get to that point where demand outstripped supply across goods and services markets in general.
Does any of that change as the pandemic recedes?
Many of the natural price swings which could have occurred during the pandemic were suppressed as during war. Now we have the bottlenecks of disrupted supply lines and spill-over from asset inflation (bitcoin mining related demand for chips, sky high prices in commodities, housing inflation spilling over into rents). And a race to the bottom of the fiat monies persists. We can say that there is monetary inflation by comparing with the counterfactual of a sound money regime under which such a jump in prices across the board would have triggered a tightening of money markets.
Still, combustion of monetary inflation into sustained high CPI inflation may be elusive. Possible obstacles include widespread awareness of huge tax bills in the future and overall economic setback due to the pandemic, never mind the optical illusions of stellar quarterly growth from the low-point and huge fiscal transfers. We should also take account of an overhang of potential malinvestment from the pandemic itself most of all in the area of digitalization.
Bottom line: how the Great Monetary Inflation of 2011/12 will end and whether it includes a combustion process into high sustained CPI inflation are wide-open questions at this point. The balance of present and past evidence suggests that no combustion is still one mainstream scenario where an endogenous process of asset inflation turning to asset deflation sets in first. The small size of the history laboratory, however, does not include for the modern era (since say 1919) another decade and potentially more of virulent asset inflation without a meaningful monetary counterattack.